Green Street recently highlighted the “sea change” occurring in private markets with U.S. private-equity backed firms that have grown from one-fourth to now two times the size of the public market universe over the past two decades. In the commercial real estate industry, that growth is evident in a surge of capital flowing into private equity funds and non-listed REITs.
Closed-end fund “dry powder”—capital that has been committed but not yet called—is at an all-time high of approximately $200 billion, according to Green Street. Although closed-end funds still account for a majority of net inflows into real estate, there also is a clear trend of accelerating growth in “perpetual capital” vehicles, namely non-traded REITs and open-ended core-plus funds. For example, non-traded REITs fundraising hit a new high of $36.5 billion last year and Robert A. Stanger & Co. is forecasting further growth to $45 billion for 2022.
According to Green Street, the shift towards perpetual capital investment vehicles has been fueled by big-name players that include the likes of Blackstone, Starwood, Cantor Fitzgerald and KKR among others. WMRE recently talked with David Bragg, co-head of strategic research at Green Street to hear more about how the surge in capital raising by perpetual capital vehicles is impacting the broader commercial real estate investment market.
This interview has been edited for style, length and clarity.
WMRE: In your recent Property Insights article, you dig into the topic of perpetual capital and the shift towards private versus public market investment vehicles. How are you defining perpetual capital?
David Bragg: For real estate, there are two major components. One would be non-traded REITs, which tend to cater towards the wealth channel more so than the institutional channel, and there also are (open ended) core plus funds. Those are the two main perpetual capital strategies that I’ve seen from real estate private equity firms. There might be other types of firms that have greater perpetual capital strategies, but when we talk about it, we’re really talking about real estate private equity in core plus and non-traded REIT strategies.
WMRE: Would you consider listed REITs as part of this bucket of perpetual capital?
David Bragg: I think listed REITs are perpetual capital. When we talk about the rise of private equity perpetual capital, we don’t include them in the conversation because they are not sponsored by private equity firms, but the nature of listed REIT capital is perpetual in nature.
WMRE: What is driving that surge in capital flows for perpetual capital strategies and perhaps non-traded REITs specifically?
David Bragg: The non-traded REIT vehicle has existed for some time, but previously it had poor sponsorship and tended to be focused on specific sectors. Governance was poor and fees were higher than what they are today. As evidenced by fundraising that occurred back in the 2000s, it is a concept that did resonate with investors, and specifically high net worth investors. It’s really not viewed as an institutional investment vehicle.
Blackstone, with its strong track record and strong brand name, was able to reinvent this vehicle and build one that had great appeal to high-net-worth investors, who presumably admired Blackstone and their accomplishments in real estate. And it offered a better fee structure than what we had seen in the past. Fees are still higher than those of listed REITs for example, but performance on a net basis is better than that of listed REITs, thanks in large part to Blackstone’s successful approach to sector allocation.
WMRE: What do you think are some of the broader implications of more private equity perpetual capital flowing into the real estate industry?
David Bragg: There are so many implications. First, because these entities have raised so much capital and have so much to deploy, what these perpetual capital vehicles want to invest in is therefore in greater demand and has been performing well. It’s moving the market in terms of pricing. Another consideration is that because these perpetual vehicles are expected to hang on to the assets they buy for such a long time, it has created—at least a perception, which may be real—of scarcity in the marketplace.
There are other implications. Real estate private equity funds historically have focused on finite life vehicles. They might underwrite a seven-year hold where they needed to buy it well and sell it well, and operations weren’t a huge focus of private equity real estate funds. Now they are. If you’re going to hold onto something much longer and be growing in a permanent way in specific property sectors, it causes one to focus more on operational excellence. To achieve that, what we’ve observed, is the private equity real estate funds are increasingly interested in having platforms of their own in various property sectors. That has resulted in, or contributed to, an increase in privatization activity of REITs. Of course, they can buy platforms from the private market too, but just recently Blackstone announced plans to buy American Campus, a student housing operating platform.
There are many interesting implications. One last one to highlight is another consideration that I would pose more as a question than a statement. Is what has traditionally been a two-way street between real estate private equity firms and the public market going to look more like a one-way street going forward? What I mean by that is, will there continue to be privatization of REITs due to the need for platforms and the need to buy more assets? And will there be less IPOs because you don’t have those finite life funds that are coming to an end, and you don’t have as much of a need to sell assets if you’re going to be holding assets? That remains to be seen, but I wonder about it.
WMRE: With all of this liquidity, is it creating a bit of a bottleneck to push out some of this capital? As an example, Blackstone has $25 billion in inflows just from its non-traded REIT platform last year. What are the implications for all of that dry powder?
David Bragg: It does create some level of urgency on the need to spend the capital. I’m not saying that this has been or will be the case, but what we can watch for is what does that result in in terms of evolution of the strategy. Can a firm that’s raising perpetual capital and needs to spend so much money maintain its focus on the areas where it sees the greatest potential for outperformance? Or do you need to move down the totem pole, for lack of a better term, as it relates to return expectations and invest in some things that are less attractive? That is one question that comes to mind.
WMRE: Are some of these capital inflows driving more activity in portfolio level and entity level transactions versus some of the traditional one or two asset acquisitions?
David Bragg: I would agree with that. You have seen a number of big portfolio deals, and I would expect more. I don’t know that the biggest deals of this cycle are as large as the biggest ones the occurred in the last cycle, so far. Pre-financial crisis there were a couple of really big standouts with Equity Office Properties and Archstone. (Blackstone acquired EOP for $23 billion in 2007, while Tishman Speyer and Lehman Brothers acquired Archstone-Smith for $22.2 billion in 2007.) I do wonder why we haven’t seen even bigger deals getting done given the amount of capital that needs to be put to work, and put to work fairly quickly.
WMRE: Capital certainly seems to be gravitating towards these bigger established players. Does that suggest that you really need scale in this market in order to compete, or is there room at all levels for different size platforms?
David Bragg: There are always opportunities for new entrants and for innovative approaches. Although it seems as though, to some extent, we’re seeing consolidation of the institutionally owned real estate universe, there will always be opportunities for new groups to come in and succeed.
WMRE: Do you think that fundraising momentum will continue?
David Bragg: I don’t know. It remains to be seen. Everything remains in flux right now given the turbulence in capital markets. One other thing to mention about the appeal of non-traded REITs is that, on the surface, they are not as volatile as listed REITs. They are not repriced and traded daily in the market. Appraisals are updated monthly and tend to move slowly. Over the past month with REITs down 15 percent, while Blackstone has taken a slightly positive or flat mark in its non-traded REIT portfolio.
Our view is that the volatility of listed REITs is an opportunity, and it’s not a threat. Historically, listed REITs have performed very well relative to private market real estate, and the best time to buy listed real estate has proven to be times like this when they trade at big discounts to the underlying value of their assets in the private market.